The impact of fiscal decentralization on economic growth: A comparative analysis of selected African and OECD countries

Abstract

Fiscal decentralization, widely believed to be one essential tool to boost economic growth, is typically presented as something that works for developed countries. However, this needs to be investigated, which is what this paper aims to do. This paper investigates the relationship between fiscal decentralization and economic growth, specifically focusing on its applicability in both developed and developing countries. Using cross-sectional data from 23 African and 23 OECD countries, we employ two-stage estimation methods, including two-stage least squares (2SLS), Generalized Method of Moments (GMM), and Limited Information Maximum Likelihood (LIML), to address concerns related to endogeneity. The inclusion of instruments representing country size, ethnoreligious diversity, and administrative structure enhances the analysis. The dependent variable is based on average values for the five-year period between 2015 and 2019, while the explanatory variables are derived from data in 2017, representing the midpoint of the 2013–2021 period. The results highlight the effectiveness of the 2SLS method in estimating the relationship between fiscal decentralization, control variables, instrument variables, and per capita GDP. Empirical findings indicate significant positive impacts of both expenditure decentralization and revenue decentralization on per capita GDP, holding true for both developed and developing countries, with a slightly stronger effect observed in the latter. These results underscore the potential benefits of fiscal decentralization across diverse economies and offer valuable insights for policymakers.The study uses cross-sectional data from 23 African and 23 OECD countries and applies two-stage estimation methods to effectively address the endogeneity issue in the modeling. A variety of such methods in two-stage least squares (2SLS), Generalized Method of Moments (GMM), and Limited Information Maximum Likelihood (LIML) are applied and compared against the ordinary least squares (OLS) method. Variables that represent the size, the ethnoreligious diversity and the type of administrative structure of the countries are employed as instruments. The 2SLS method proved to excellently estimate the relationship between the fiscal decentralization terms as well as other control and instrument variables and the per capita GDP. The findings from the empirical analysis showed that both expenditure decentralization and revenue decentralization have significant positive impacts on per capita GDP of a country. This relationship holds not only for developed countries but also for developing ones, even to a slightly better degree in the latter.